What Apple (Nasdaq: AAPL) Must Do to Soar Again

Jason Jenkins writes: The story of Apple (Nasdaq: AAPL) is an intriguing one.

Steve Jobs created a brand as strong as Coke (NYSE: KO) or Nike (NYSE: NKE). That’s a statement in itself. Apple’s brand loyalty is so strong, a Marco Rubio anti-Apple tweet induced responses of party switching. Who knew smartphone preference could be a political party deal breaker.

For years it was just assumed the value of Apple’s stock would skyrocket – forever and ever. Why not? It gave us the iPhone and iPad. Senator Rubio learned you don’t bad-mouth an iPhone.

Innovation led to record-breaking quarterly profits and expectations. Soon, analysts and pundits were talking of $1000 a share and $1 trillion in market value. Just the mention of those accolades being possible is like hallowed ground in the financial world.

But something happened on the way to market immortality. The stock has plummeted since September of 2012. It’s currently gone from $700 per share to hovering in the mid-$400 range. There isn’t a clear consensus in the market of what’s happening. Some think this is a blip, while others believe Apple’s future is in trouble.

But here’s what is really going on with Apple.

Apple’s Capital Allocation Problem
Not familiar with capital allocation? Well here’s the definition:

It is the manner in which a corporation allocates its financial resources and other sources of capital to processes, projects and employees. Specifically, it is a corporation’s process to maximize capital allocation so that it generates the most wealth for its shareholders.

If that’s too textbook for you, here it is in layman’s terms. Apple got too much cash, and it isn’t giving the vast majority back to its shareholders. It also doesn’t seem to be investing much of it to increase value…

How much cash is too much? Apple is sitting on $137 billion in cash and will be adding another $40 billion a year to that number. Investors want some of that cash returned to shareowners.

If Apple does that, it would definitively bump up the share price and maybe swing it back up the path to where it was late last summer.

So what is Apple currently doing? The current quarterly dividend is $2.65. That adds up to about $10 billion a year. Apple also repurchased nearly $2 billion in stock last quarter. This was done to offset share dilution from equity compensation.

So now the market wants Apple to explain what it’s doing with all this extra cash. Why the modest dividend, and why isn’t it buying back more stock? And renowned value mutual fund manager Bill Miller believes other major “brands” out there show us, if Apple changed its capital allocation, its stock could skyrocket 50%.

Here’s the thinking behind the statement. At Apple’s current price, it’s trading about nine and a half times earnings. Most analysts predict that for 2013, Apple will probably grow about 15% to 16%. Growth is expected to be around 12% to 14% for 2014. If you look at a company like McDonald’s (NYSE: MCD), which pays out 100% of free cash flow to shareholders… It trades at 15 to 16 times earnings. Thus, your price bump.

Not All Cash is Created Equal
There is a little problem with the analysis mentioned above. Not all of the $137 billion is available to give back to shareholders. Around $85 billion aren’t located on U.S. soil. If Apple brought the money back, it would have to pay taxes on it, and the company hasn’t given any indication it’s willing to take on that burden.

But a major overhaul of how Apple handles its cash may be the only game changer that could have the company soar again. A 15% dividend hike will not be adequate. You need to get value investors to join the party, and the only way that is likely to happen is a dividend in the 3% to 4% range.

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